Author Topic: Discussion: Unless you're retired dividends are an inefficent, drag on portfolio  (Read 16410 times)

danclarkie

  • 5 O'Clock Shadow
  • *
  • Posts: 85
  • Age: 32
  • Location: Dubai & Singapore
  • Measure Twice, Cut Once.
    • Dan Clarke
I wrote an article on this a while ago, focusing on the inefficiency of non-US citizens investing in dividend yielding US companies.
The IRS subjects US domiciled funds to a 30 tax withholding on dividend payments to non-US citizens.
Whilst you can reduce this to 15% with Irish domiciled funds, it's still and inefficiency.

http://expatfinance.net/the-inefficiency-of-us-dividends-for-expat-growth-investors

My article pissed off some of the dividend apologists, but I remain unchanged in my views.

Having given it some more thought, I am actually more convinced of my theory that dividend payments are an inefficient drag on your portfolio, unless you are in a position that you need to withdraw cash from your investments to cover your cost of living.

Whilst still in the growth phase of your investment career, you want to stick all of your money into funds and get more equity/more shares.
If you're employed and your employment covers your cost of living, and you have an emergency fund in place, then the fact is you do not want cash money.

Unless you are withdrawing from your portfolio, you absolutely do not want it to be producing liquid cash.
In fact, you take the liquid cash you get each month and exchange it for more equity/shares.
You already have an abundance of cash, from your job/income, why would you want your portfolio to also be producing liquid cash and increasing that surplus?!

The killer is, we take these dividend payments and then use the cash to buy up more shares/equity, and get hit with commission and trading fees!

If the ETF provider instead took those dividend payments and used them to increase the holdings of the ETF, rather than pay out a dividend to the ETF holder, surely this would be more efficient.

Equally, though "share buybacks" get a bad rep, for a growth investor that doesn't need the cashflow, a company using its excess cash to execute share buybacks and drive up the equity and share price of existing stock holders is surely a more efficient play?

IMO, those following a dividend stock strategy from day one of their investment careers are losing a chunk of change to brokerage commissions and are following a substantially sub-optimal investment strategy.

What am I missing here?

danclarkie

  • 5 O'Clock Shadow
  • *
  • Posts: 85
  • Age: 32
  • Location: Dubai & Singapore
  • Measure Twice, Cut Once.
    • Dan Clarke
The 30% tax (or lower treaty rate) to which you refer is imposed by 26 USC § 871 on nonresident aliens. All US entities are required to withhold the same from enumerated payments to nonresident aliens pursuant to 26 USC § 1441.

The point I want to mention is that this tax only applies to nonresident aliens. A US resident who is not a citizen is not subject to this tax (although they are, of course, subject to ordinary graduated income tax).

All or most tax treaties to which the US is a party provide that the US may not tax US residents less favourably than US citizens. So if a US tax statute actually treated US residents in an unfavourable manner relative to citizens, it would be overridden by those treaties to the extent the person in question is a citizen of a treaty country.

Sure, I mention it just in passing to explain my personal distaste for dividends.
But I wanted to speak mostly about the issue of commissions and fees being a drag on DRIP plans, regardless of any tax issues that may be placed on dividends.

Also, as for this:

If the ETF provider instead took those dividend payments and used them to increase the holdings of the ETF, rather than pay out a dividend to the ETF holder, surely this would be more efficient.

In order to enjoy beneficial tax statuses, these funds are typically required to distribute most of the dividends they receive. Of course, the exact laws will vary by country.


I'd be keen to understand what you mean by this as this is new to me :)
I understand the distribution requirements on REITs, but I'm not aware of any such requirements on ETFs such as index tracking funds.

danclarkie

  • 5 O'Clock Shadow
  • *
  • Posts: 85
  • Age: 32
  • Location: Dubai & Singapore
  • Measure Twice, Cut Once.
    • Dan Clarke
Since this thread has an international flavour, I wasn't intending to refer to any particular country's laws with my statement about ETFs, since it varies. It also depends on the legal structure of the ETF. It was just my intent to alert you to a possible reason that ETFs may distribute dividends.

For example, in Canada, if an ETF is structured as a trust then it has to distribute dividends, but if it's structured as a corporation it doesn't.

I see, I guess this ties in with my understanding of a REIT then, as the distribution requirement applies to all investments that are held in Trust?
I realize this is country specific in terms of legality, but broadly speaking, the US, Canada, EU, etc?

beltim

  • Magnum Stache
  • ******
  • Posts: 2884
Equally, though "share buybacks" get a bad rep, for a growth investor that doesn't need the cashflow, a company using its excess cash to execute share buybacks and drive up the equity and share price of existing stock holders is surely a more efficient play?

IMO, those following a dividend stock strategy from day one of their investment careers are losing a chunk of change to brokerage commissions and are following a substantially sub-optimal investment strategy.

What am I missing here?

In principle, I completely agree that share buybacks are better for investors because of tax efficiency.  In practical terms, however, they aren't as good as dividends because management is terrible at market timing.  What do I mean by this?  Well, unlike dividends, which in the US (unlike much of Europe) are relatively fixed, share buybacks are usually cyclical, and share buybacks peak when market prices peak, and trough when market prices trough.  On average this destroys shareholder value relative to dividends.  See for example page 12 of this report, which found that stock buybacks underperformed the market 77% of the time  (https://doc.research-and-analytics.csfb.com/docView?language=ENG&source=emfromsendlink&format=PDF&document_id=979523241&serialid=cbWwRRD8BPCNJ%2B%2BehG6tXJo50lwZZncJDGPsGRFN%2B54%3D)


okonumiyaki

  • Stubble
  • **
  • Posts: 177
I DRIP any individual shares I own that pay dividends, and offer scrip instead of dividends.

For ETF and shares that don't have scrip, I try and reinvest the dividends ASAP as rebalancing (i.e. not necessarily back into the asset that paid the dividend, but into the one that is most under target %)

sol

  • Walrus Stache
  • *******
  • Posts: 8488
  • Age: 43
  • Location: Pacific Northwest
What am I missing here?

I think that for many dividend investors, the secret sauce is in the reduced volatility of regular payments.  They're accepting lower total returns in exchange for dividend payments that remain relatively constant from year to year.

From that perspective, dividend stocks are clearly inferior to non-dividend-paying stocks, but clearly superior to US Treasuries or other relatively guaranteed low-rate investments.  Many people who buy dividends are people who might not otherwise be buying stocks at all.

danclarkie

  • 5 O'Clock Shadow
  • *
  • Posts: 85
  • Age: 32
  • Location: Dubai & Singapore
  • Measure Twice, Cut Once.
    • Dan Clarke
I DRIP any individual shares I own that pay dividends, and offer scrip instead of dividends.

For ETF and shares that don't have scrip, I try and reinvest the dividends ASAP as rebalancing (i.e. not necessarily back into the asset that paid the dividend, but into the one that is most under target %)

I see.
The value of taking dividends from a high performing stock and using them to buy more equity in a low performing stock makes sense, however it seems more of a case of making the most of a bad situation.
You are still getting inefficient cash out of your investments and losing on the fees.
You would be better off rebalancing with your regular cash contributions from your income (which I'm sure you do), but I take the point.



What am I missing here?

I think that for many dividend investors, the secret sauce is in the reduced volatility of regular payments.  They're accepting lower total returns in exchange for dividend payments that remain relatively constant from year to year.

From that perspective, dividend stocks are clearly inferior to non-dividend-paying stocks, but clearly superior to US Treasuries or other relatively guaranteed low-rate investments.  Many people who buy dividends are people who might not otherwise be buying stocks at all.

I suppose that is one benefit, the regularity of payments mostly regardless of the volatility of the stock/fund value.
If that is worth the associated commissions/fees overhead I suppose is an individual choice, but for an investor in the growth/accumulation phase I would think we generally agree it is not.

Regular payments and reduced volatility is, of course, exactly what you want in retirement.
It seems the broad strokes of my feelings on dividend stocks are mostly correct.

neil

  • Stubble
  • **
  • Posts: 216
Of course taxes will drag returns and, all things equal, dividends in taxable accounts are not ideal.

http://www.thornburginvestments.com/pdfs/th1401.pdf

This conversation is a bit out of context with the first graph but it is a good representation of how much return is eroded by taxes.  Dividend tax is just as significant as capital gains tax, but capital gains can be deferred through holding.  (And by holding long enough, maybe the tax rate will be 0% by selling in retirement when AGI is low.  Not sure on your situation, though.  The taxes are based on US scenarios.)

It is odd that one of the first lessons of investing is that it matters how much you invest and not the price or share count.  But after 40 years of investing, why start associating preservation of share count with preservation of capital?  The two are not equivalent.

Regarding share buybacks, one of the stocks I like to keep my eye on is AZO.  They've reduced their share count by about 80% over the last 15 years.  Their business is a cash cow if run well and isn't going anywhere, but the market is pretty saturated.  If they aren't sacrificing business interests for it (they do have negative book value, so it's a fair question) there is a lot of value in it.  During the 2008-2009 recession, the price remained stable because they continued to buy up shares when everyone else was selling.

danclarkie

  • 5 O'Clock Shadow
  • *
  • Posts: 85
  • Age: 32
  • Location: Dubai & Singapore
  • Measure Twice, Cut Once.
    • Dan Clarke
Of course taxes will drag returns and, all things equal, dividends in taxable accounts are not ideal.

Even in tax sheltered accounts, or in tax free jurisdictions, the commissions and brokerage fees alone make dividends inefficient, was the main point I was looking at :)

Even in such a tax free scenario, dividend payments are an inefficient investment return.

I suppose the main draw is the same reason why the average Joe extols the idea of owning a rental property.
The easy to grasp concept of cash flow generating investments is easier to get your head around than the idea of a growth stock portfolio with no distributions.

But I read so many "dividend stock only" investment plans, all from investors in the growth/accumulation phase of their careers.
If it is empirically proven that the dividend growth strategy is inefficient, why is it so popular?

neil

  • Stubble
  • **
  • Posts: 216
There are studies such as this which show dividend payers outperform:

http://www.suredividend.com/wp-content/uploads/2014/03/Dividends-A-Review-of-Historical-Returns.pdf

I would not bet against history, but I wonder if information like this was not readily available prior to 1980 or so.  Nowadays we have computers who can analyze prior returns to death and erode any advantage if there ever was one.  It would be interesting to try and add a cost factor.

Regarding costs, many American online brokerages have alternatives.  Many offer a selection of ETFs commission free (with a short-term penalty) and drips can be enrolled in if you are committed to your selections.  My Fidelity 401K has a brokerage option which again comes with commission free options.

FarmerPete

  • Bristles
  • ***
  • Posts: 346
I'm not sure if this option is available to you, but I have my investments setup for automatic reinvestment of dividends.  Fidelity offers this service for free.  No commissions or fees are paid as far as I can tell.  It does make for a lot of fractional shares though.  :-)

skyrefuge

  • Handlebar Stache
  • *****
  • Posts: 1007
  • Location: Suburban Chicago, IL
But I read so many "dividend stock only" investment plans, all from investors in the growth/accumulation phase of their careers.
If it is empirically proven that the dividend growth strategy is inefficient, why is it so popular?

Because there are a lot of investors out there who don't think as critically about these things as you do. I assume the bizarrely-confrontational and confused comments on your blog post from Dividend Mantra told you something about his intellectual prowess.

The main reason dividend-focused strategies remain popular is due to a psychological and emotional error that almost all of us are subject to. You illustrated it in your blog post when, while contrasting a dividend-based income strategy in retirement to a total-return approach, you said "This intuitively feels like a much more sustainable plan that can be maintained indefinitely and provide a passive income." You're right that taking dividends intuitively feels better than selling shares, but it's not actually logically or mathematically better. That's just your emotions playing tricks on you. Even in retirement, there is no financial benefit to adopting a dividend focus (though the downside is less than it is during the accumulation phase).

Some of us can use our higher-level consciousness to overcome that emotional bias. But those who are not even aware that they suffer from this emotional bias instead frequently dive headfirst into the pool of sweet, sweet dividends and never ever get out, even as they watch the taxman and the market rifle through their wallet that they left on the pool deck.

Financial.Velociraptor

  • Handlebar Stache
  • *****
  • Posts: 1499
  • Age: 47
  • Location: Houston TX
  • Devour your prey raptors!
    • Financial Velociraptor
DanClarkie,

You assume dividends get reinvested AND that a fee is charged for such reinvestment.  In my case (FIRE), I spend my dividends; growth comes from trading options and said proceeds are invested "lumpily" at a low cost broker (IB) where I usually pay: 1 dollar/trade.  My frictional cost of trading is immaterial.  I'd also note that some brokers (take ShareBuilder as an example) will DRIP your dividends for the low, low cost of FREE; including holding fractional shares on your behalf.

Taxes?  Qualified Dividends (almost all of my distributions) are taxed at a favorable rate that is equal to what my Long Term Capital Gains tax rate would be.  Any tax penalty I pay is trivial (usually on the sliver of distributions that are categorized as short term return of capital [partnerships such as MLPs]).  Your [foreign] mileage may vary.

I think it is also important to note there are many studies that show, on the whole, dividend paying stocks outperform non-dividend paying stocks.  (This gets a little fuzzy when comparing to index investing b/c in the US, most of the index will pay divs.) 

Your arguments make sense to me on a theoretical level but also remind me of the argument from my MBA Finance classes that for tax efficiency, firms should use 100% debt financing and no equity financing.  [My professors could never answer how a firm could exist with literally no owners...]  Likewise, you posit a world where firms that never return profits to shareholders still have value.  The theoretical value of shares is equal to the present value of all estimated future cash flows, but the theory breaks down if the firm hoards its gains till Kingdom.  I'll take my divs.

beltim

  • Magnum Stache
  • ******
  • Posts: 2884
But I read so many "dividend stock only" investment plans, all from investors in the growth/accumulation phase of their careers.
If it is empirically proven that the dividend growth strategy is inefficient, why is it so popular?

Because there are a lot of investors out there who don't think as critically about these things as you do. I assume the bizarrely-confrontational and confused comments on your blog post from Dividend Mantra told you something about his intellectual prowess.

Ugh.  It hasn't been empirically proven that a dividend strategy is inferior to other uses of capital.  You have nice mathematical proofs that show that taxes on dividends reduce returns (not very much, because they're so overwhelmingly held in tax-advantaged accounts or are taxed at 0%, but yes! some).  But no one has shown any data that companies that pay dividends are less efficient allocators of capital than those that do. In fact, the only data on that is what I posted, which showed that due to the same behavioral factors that skyrefuge discussed, stock buybacks are timed incredibly poorly, destroying shareholder wealth in a significant percentage of cases.  In fact, the more frequent and consistent the stock buyback (the more dividend-like they are), the better buybacks do on average.

So yes, in a perfect world dividends are inefficient.  But because managers are humans subject to the same emotional bias that when times are good at that company, they should buy back more stock, in real life buybacks on average are not as good as dividends on average.  There's real, hard data to support this, and I've given you one study to get you started.

Financial.Velociraptor

  • Handlebar Stache
  • *****
  • Posts: 1499
  • Age: 47
  • Location: Houston TX
  • Devour your prey raptors!
    • Financial Velociraptor
But I read so many "dividend stock only" investment plans, all from investors in the growth/accumulation phase of their careers.
If it is empirically proven that the dividend growth strategy is inefficient, why is it so popular?

Because there are a lot of investors out there who don't think as critically about these things as you do. I assume the bizarrely-confrontational and confused comments on your blog post from Dividend Mantra told you something about his intellectual prowess.

The main reason dividend-focused strategies remain popular is due to a psychological and emotional error that almost all of us are subject to. You illustrated it in your blog post when, while contrasting a dividend-based income strategy in retirement to a total-return approach, you said "This intuitively feels like a much more sustainable plan that can be maintained indefinitely and provide a passive income." You're right that taking dividends intuitively feels better than selling shares, but it's not actually logically or mathematically better. That's just your emotions playing tricks on you. Even in retirement, there is no financial benefit to adopting a dividend focus (though the downside is less than it is during the accumulation phase).

Some of us can use our higher-level consciousness to overcome that emotional bias. But those who are not even aware that they suffer from this emotional bias instead frequently dive headfirst into the pool of sweet, sweet dividends and never ever get out, even as they watch the taxman and the market rifle through their wallet that they left on the pool deck.

skyrefuge,

I'm one of the True Believers so to speak.  I don't see how I'm getting reamed by the taxman in retirement.  As I noted above, I pay the same rate on essentially all my distributions as I would on LTCG.  My dividend stream provides a very stable (and slowly growing) budget.  If I were on a pure non-div basis, and deducted 4% (the magic number?) every year, I wouldn't know what my budget would be in the future [at the mercy of the market.]  I disagree that my approach is fundamentally worse than your yours for this reason.  Even if it were, I'd pay a few points for the stability.  It's the same thing as my municipal bonds.  They will underperform the broad market but reduce volatility and provide a fixed monthly coupon (yes, also less tax efficient.) 

Look, I don't poop on non-dividend stocks either.  I like and own several non-div paying insurance companies because I expect them to as a group outperform the broad market over decades.  I mostly hold these in my tax advantaged account that I can't (won't?) touch for a couple decades and I just want it to be known I don't have "dividend blinders."  (side note: I also own some SYLD and FYLD, which incorporate all three legs of 'shareholder return' plus a momentum component.) 

I'm not going to ramble any more.  I'm just going to recommend the book "What Works on Wall Street" by James O'Shaughnessy as evidence there are non-index investing approaches that are [equally] valid.

Financial.Velociraptor

  • Handlebar Stache
  • *****
  • Posts: 1499
  • Age: 47
  • Location: Houston TX
  • Devour your prey raptors!
    • Financial Velociraptor
I'll throw out some food for thought: why do you think Warren Buffet likes dividend paying stocks so much?  Maybe he is 'sorta stupid.' 

brooklynguy

  • Handlebar Stache
  • *****
  • Posts: 2204
  • Age: 39
The compelling emotional appeal of dividends stems from the attractiveness of the argument that we buy chickens for their eggs, and stocks for their dividends.  Everyone knows you don't kill a goose that's laying golden eggs, right?.  But this excellent post by grantmeaname (or just about any post by skyrefuge on the topic) should help the unenlightened to see that when a company issues a dividend, it is slaughtering chickens just as surely as you are when you sell a share.

MrSal

  • Pencil Stache
  • ****
  • Posts: 885
I wrote an article on this a while ago, focusing on the inefficiency of non-US citizens investing in dividend yielding US companies.
The IRS subjects US domiciled funds to a 30 tax withholding on dividend payments to non-US citizens.
Whilst you can reduce this to 15% with Irish domiciled funds, it's still and inefficiency.

http://expatfinance.net/the-inefficiency-of-us-dividends-for-expat-growth-investors

My article pissed off some of the dividend apologists, but I remain unchanged in my views.

Having given it some more thought, I am actually more convinced of my theory that dividend payments are an inefficient drag on your portfolio, unless you are in a position that you need to withdraw cash from your investments to cover your cost of living.

Whilst still in the growth phase of your investment career, you want to stick all of your money into funds and get more equity/more shares.
If you're employed and your employment covers your cost of living, and you have an emergency fund in place, then the fact is you do not want cash money.

Unless you are withdrawing from your portfolio, you absolutely do not want it to be producing liquid cash.
In fact, you take the liquid cash you get each month and exchange it for more equity/shares.
You already have an abundance of cash, from your job/income, why would you want your portfolio to also be producing liquid cash and increasing that surplus?!

The killer is, we take these dividend payments and then use the cash to buy up more shares/equity, and get hit with commission and trading fees!

If the ETF provider instead took those dividend payments and used them to increase the holdings of the ETF, rather than pay out a dividend to the ETF holder, surely this would be more efficient.

Equally, though "share buybacks" get a bad rep, for a growth investor that doesn't need the cashflow, a company using its excess cash to execute share buybacks and drive up the equity and share price of existing stock holders is surely a more efficient play?

IMO, those following a dividend stock strategy from day one of their investment careers are losing a chunk of change to brokerage commissions and are following a substantially sub-optimal investment strategy.

What am I missing here?

You're not missing anything... You are right.

Dividends are inefficient. And that's why Warren Buffet doesn't pay Dividends to Berkshire investors.

The only time you'd want Dividends is if the company had married so much that the return they can get on the whole money they have is lower than you'd normally get. Think very mature companies like Walmart coca cola  etc...

Retire-Canada

  • Walrus Stache
  • *******
  • Posts: 7345
  If I were on a pure non-div basis, and deducted 4% (the magic number?) every year, I wouldn't know what my budget would be in the future [at the mercy of the market.]

The 4% SWR that gets bandied around is 4% of the investment value at retirement so $40K on $1M. It's not a variable 4% of the current value of the investments.

If you need $40K/yr to live on the year you retire you aren't going to need $160K/yr just because your investments have done well. Your still going to need $40K/yr +/- some natural fluctuation.

-- Vik

Financial.Velociraptor

  • Handlebar Stache
  • *****
  • Posts: 1499
  • Age: 47
  • Location: Houston TX
  • Devour your prey raptors!
    • Financial Velociraptor
  If I were on a pure non-div basis, and deducted 4% (the magic number?) every year, I wouldn't know what my budget would be in the future [at the mercy of the market.]

The 4% SWR that gets bandied around is 4% of the investment value at retirement so $40K on $1M. It's not a variable 4% of the current value of the investments.

If you need $40K/yr to live on the year you retire you aren't going to need $160K/yr just because your investments have done well. Your still going to need $40K/yr +/- some natural fluctuation.

-- Vik

Thanks Vik,

I live entirely off passive portfolio income so have not properly studied the SWR approach.  You could say my WR is actually -0- and I like it that way.

brooklynguy

  • Handlebar Stache
  • *****
  • Posts: 2204
  • Age: 39
I live entirely off passive portfolio income so have not properly studied the SWR approach.  You could say my WR is actually -0- and I like it that way.

This is exactly the misconception that we are trying so hard to dispel!  Even if your dividend income exceeds your spending, you can't say that you are using a 0% WR any more than I can say I'm using a 0% WR when I sell shares to meet my spending needs.

Financial.Velociraptor

  • Handlebar Stache
  • *****
  • Posts: 1499
  • Age: 47
  • Location: Houston TX
  • Devour your prey raptors!
    • Financial Velociraptor
I live entirely off passive portfolio income so have not properly studied the SWR approach.  You could say my WR is actually -0- and I like it that way.

This is exactly the misconception that we are trying so hard to dispel!  Even if your dividend income exceeds your spending, you can't say that you are using a 0% WR any more than I can say I'm using a 0% WR when I sell shares to meet my spending needs.

brooklynguy,

The 4% WR approach used by FireCalc and the like take a statistical look at withdrawing CAPITAL from the portfolio and coming up with a percent likelihood the stash will outlive the stashholder.

My approach assumes a 0% WR of CAPITAL (not 0% withdrawal of funds).  I have to make an assumption that dividends won't be cut but that yields a 100% success rate as capital is never depleted.  What are the odds if you build a portfolio of companies entirely from the Aristocrats list (companies that have raised distributions every year for at least 25 consecutive years) that your divs won't be cut in the future?  Well, I have no crystal ball but I think the net affect maybe one or two cuts versus 23 consistent raises beats your cfirethingy 95% success rate.  [Speculation - can't "prove" this]

That capital withdrawal versus income withdrawal approach are apples and oranges to each other.  Why does everyone insist they should be considered on some kind of 'equal' basis? 

brooklynguy

  • Handlebar Stache
  • *****
  • Posts: 2204
  • Age: 39
The 4% WR approach used by FireCalc and the like take a statistical look at withdrawing CAPITAL from the portfolio and coming up with a percent likelihood the stash will outlive the stashholder.

No, the 4% SWR research and the history-based calculators it inspired all look at withdrawing MONEY from the portfolio.  The percentage likelihoods of success or failure (based on historical performance) take into account TOTAL RETURN (which includes both dividends/interest and capital appreciation).

A "capital withdrawal" approach and an "income withdrawal" approach are not apples and oranges.  They are simply different names for the same apple.

Of course your approach of never spending less than the dividends you receive ensures that you will never run out of money.  If you take the approach of never spending less than your total return in any given year, that will also ensure that you will never run out of money.

"Cfirethingy" and similar tools simply allow you to see how your approach would have fared historically, assuming you were invested in total-market type vehicles.

I have no objection to anyone's decision to focus on dividend-paying stocks as their investing strategy, as long as they do so on an informed basis.  I do have an objection to the idea that there is an inherent economic difference between the receipt of a dividend and the receipt of proceeds from the sale of shares, which is simply false, and it is this false premise that underlies many investors' decision to follow a dividend-focused strategy.

FarmerPete

  • Bristles
  • ***
  • Posts: 346
Since my dividends get reinvested for no commision costs, I look at it as a way to naturally raise my cost basis over time.  If I have a stock that I bought for $100 a share with a 4% dividend, and it goes up 10% every year...by the time it reaches $200 a share, my cost basis will be significantly higher than $100, as each purchase of stock with my dividends will naturally raise my cost basis.  Sure, I'll pay taxes on the dividends, but for me, that's typically zero dollars.

Realistically though, I prefer to own ETFs vs Mutual Funds in some of my accounts.  I'll do that because often the expense ratio of the ETF is less than a similar mutual fund.  For example, at Fidelity, I can get IVV (iShares S&P 500 ETF) with no trading fees and a 0.07% expense ratio.  That's the same as the Spartan Advantage class mutual fund, but without the $10k investment minimum.  The only downside is that you have to make additional investments in full share price increments.  In other words, if I want to invest $500 and the stock is worth $80.94, I buy 6 shares and leave $14.36 in cash uninvested.  Not that big of a problem in my book.  Because I am buying ETFs, they give out dividends.  I choose to reinvest those automatically.  The only real downside for me is that it makes tax time a little more difficult when you have 4 extra purchase lots for every year that you've owned a stock.  Luckily, Fidelity (and all online brokerages legally have to track it for you now if I recall), keeps track of this information for you.  It's also easily imported into things like TurboTax.
« Last Edit: February 25, 2015, 11:02:25 AM by FarmerPete »

skyrefuge

  • Handlebar Stache
  • *****
  • Posts: 1007
  • Location: Suburban Chicago, IL
Ugh.  It hasn't been empirically proven that a dividend strategy is inferior to other uses of capital.

Yep, I'm certainly not saying that such an empirical proof exists. If it did, I would put my money where my mouth is and execute an anti-dividend strategy, explicitly trying to avoid dividend-paying stocks. As far as I know, no critics of dividend-focused strategies feel the need to go that far, and no funds exist that pursue such a strategy. Highlighting the logical errors and emotional biases in a dividend-focused strategy is not the same as claiming that a dividend-focused strategy will fail.

You have nice mathematical proofs that show that taxes on dividends reduce returns (not very much, because they're so overwhelmingly held in tax-advantaged accounts or are taxed at 0%, but yes! some).

I would dispute your "not very much" qualifier. It appears that many Dividend Growth Investors intentionally avoid 401(k)-type tax-advantaged accounts, because they prevent them from directly selecting dividend-paying stocks. And this thread is about holding dividend-paying stocks in the accumulation phase, where taxes, even for US investors, are unlikely to be 0%.

So yes, in a perfect world dividends are inefficient.  But because managers are humans subject to the same emotional bias that when times are good at that company, they should buy back more stock, in real life buybacks on average are not as good as dividends on average.  There's real, hard data to support this, and I've given you one study to get you started.

Ok, I've finally spent the time to delve into these reports. I disagree with your interpretation of that data that leads you to say "in real life, buybacks on average are not as good as dividends on average".

First, if dividends are reinvested (which is the case for many dividend-focused investors during the accumulation stage), then, even in real life, buybacks are "as good as" dividends. If a "high" share price makes a buyback bad, then a dividend reinvestment at that same price is equally bad.

Next, while a buyback when the share price is high is "bad" for a continuing shareholder, it is equally "good" for a shareholder who sold his shares back to the company at that high price. In other words, the total cash returned to shareholders is equivalent whether it is returned via dividend or buyback, and whether the share price is high or low. The difference only appears once you divide the buyback shareholders into two classes, and use hindsight to point out the loser.

If an direct shareholder genuinely believes that his stock is trading above its intrinsic value (the point at which a buyback would be "bad" for a continuing shareholder), then he should simply choose to be on the "good" side by selling back to the company. Heck, he should be selling his shares regardless of any buybacks in that case.

Here are couple of reports on the topic that I found helpful. The author not only illustrates the dividend/buyback tradeoffs well, he also points out:

- the nonsense in that "most of the market's returns have come from dividends" trope
- when choosing how to return capital to shareholders, companies have made a dramatic shift from dividends to buybacks since 1982, which further highlights how a strategy that focuses dividends is becoming more and more obsolete. It would be kind of like judging a modern NFL team based on the skill of their fullback, ignoring the fact that the NFL has transitioned to a passing league and barely use a fullback anymore.

http://www.realclearmarkets.com/blog/MauboussinOnStrategyShareRepurchaseFromAllAngles_MIPX014745.pdf
http://www.realclearmarkets.com/blog/RealRoleofDividendsinBuildingWealth.pdf
« Last Edit: February 25, 2015, 12:53:02 PM by skyrefuge »

beltim

  • Magnum Stache
  • ******
  • Posts: 2884
Ugh.  It hasn't been empirically proven that a dividend strategy is inferior to other uses of capital.

Yep, I'm certainly not saying that such an empirical proof exists. If it did, I would put my money where my mouth is and execute an anti-dividend strategy, explicitly trying to avoid dividend-paying stocks. As far as I know, no critics of dividend-focused strategies feel the need to go that far, and no funds exist that pursue such a strategy. Highlighting the logical errors and emotional biases in a dividend-focused strategy is not the same as claiming that a dividend-focused strategy will fail.
You didn't, but the OP did claim that empirical proof exists, and this was meant to respond to him.

Quote
You have nice mathematical proofs that show that taxes on dividends reduce returns (not very much, because they're so overwhelmingly held in tax-advantaged accounts or are taxed at 0%, but yes! some).

I would dispute your "not very much" qualifier. It appears that many Dividend Growth Investors intentionally avoid 401(k)-type tax-advantaged accounts, because they prevent them from directly selecting dividend-paying stocks. And this thread is about holding dividend-paying stocks in the accumulation phase, where taxes, even for US investors, are unlikely to be 0%.

Well, that's a strawman, because I never argued that (it also contains several factual errors – there's nothing intrinsic to 401k plans that prevents investing in individual stocks (many allow this), and even in taxable accounts, the majority of Americans are in tax brackets that result in them paying 0% dividend taxes).  I said nothing about Dividend Growth Investors.  My point was that the vast majority of invested assets is held in tax-advantaged accounts -- not only individual 401k accounts, but also pension funds, charities, foundations, etc.  Thus, the total tax burden on dividends is a small fraction of the theoretical tax burden (or the burden faced by international investors investing in the US, like the OP).

I'll respond to your last point separately, because it deserves its own response – it actually responds to points that I made.
« Last Edit: February 25, 2015, 12:16:04 PM by beltim »

beltim

  • Magnum Stache
  • ******
  • Posts: 2884
So yes, in a perfect world dividends are inefficient.  But because managers are humans subject to the same emotional bias that when times are good at that company, they should buy back more stock, in real life buybacks on average are not as good as dividends on average.  There's real, hard data to support this, and I've given you one study to get you started.

Ok, I've finally spent the time to delve into these reports. I disagree with your interpretation of that data that leads you to say "in real life, buybacks on average are not as good as dividends on average".

First, if dividends are reinvested (which is the case for many dividend-focused investors during the accumulation stage), then, even in real life, buybacks are "as good as" dividends. If a "high" share price makes a buyback bad, then a dividend reinvestment at that same price is equally bad.

I agree with this point.  The key difference, however, is different company policies regarding dividends and stock buybacks.  As the data I provided show, companies buy back more stock when stock prices are higher, and buy back less when stock prices lower.  Dividends, however, are much more predictable than stock buybacks, and so in practice, stock buybacks have provided less value to investors than dividends.

Quote
Next, while a while a buyback when the share price is high is "bad" for a continuing shareholder, it is equally "good" for a shareholder who sold his shares back to the company at that high price. In other words, the total cash returned to shareholders is equivalent whether it is returned via dividend or buyback, and whether the share price is high or low. The difference only appears once you divide the buyback shareholders into two classes, and use hindsight to point out the loser.

I suppose this point is also true but it seems like it misses the overall point.  I personally wouldn't want management of companies I invested to preferentially reward investors who sold their stock instead of rewarding current investors.  And the data show that because of the timing of buybacks management generally rewards former investors instead of current investors.

Quote
- when choosing how to return capital to shareholders, companies have made a dramatic shift from dividends to buybacks since 1982, which further highlights how a strategy that focuses dividends is becoming more and more obsolete. It would be kind of like judging a modern NFL team based on the skill of their fullback, ignoring the fact that the NFL has transitioned to a passing league and barely use a fullback anymore.

No one is arguing for a strategy that focuses on dividends.  The OP wrote that share buybacks are more efficient than dividends, and I responded with proof that because of behavioral reasons, the real world doesn't work the same way it should on paper.  Dividend growth investing has nothing to do with my argument regarding whether it's better for management to pay dividends or buy back stock.
« Last Edit: February 25, 2015, 12:34:07 PM by beltim »

beltim

  • Magnum Stache
  • ******
  • Posts: 2884
Skyrefuge: The first article that you cited looks pretty good.  This paragraph reinforces my point:
Quote
Not surprisingly, the exhibit reveals that the year-to-year changes in capital expenditures and dividends are much more modest than those for M&A and share repurchases. Indeed, M&A and buybacks follow the economic cycle: Activity increases when the stock market is up and decreases when the market is down. This is the exact opposite pattern you’d expect if management’s primary goal is to build value.

In other words, management creates more value for shareholders through capital expenditures and dividends than through M&A and stock buybacks.

phillyvalue

  • 5 O'Clock Shadow
  • *
  • Posts: 88
  • Age: 28
  • Location: New York, NY
Dividends are a complicated subject. There are two categories of considerations: (a) how do dividends affect the value of the company, and (b) how do dividends compare in terms of tax efficiency for investors.

With (A), whether a dividend is "good" or not can only be evaluated on a business by business basis. If a company has strong investment opportunities, then it shouldn't pay a dividend. If the stock is very cheap, and management wants to return capital, buybacks are a better option.

With (B), as long-term individual investors we will be better off with capital appreciation over dividends given the tax deferral. From the perspective of the company, however, their investor base is not homogenous. While individual investors are much better off w/ appreciation because of tax deferral, tax-exempt entities like pension funds, or hedge funds investing on behalf of tax-exempt entities, don't have to worry about the tax effects of their actions. Thus a large % of the shareholder base may not care about taxes in the way individual investors in a taxable account do.

beltim

  • Magnum Stache
  • ******
  • Posts: 2884
Dividends are a complicated subject. There are two categories of considerations: (a) how do dividends affect the value of the company, and (b) how do dividends compare in terms of tax efficiency for investors.

With (A), whether a dividend is "good" or not can only be evaluated on a business by business basis. If a company has strong investment opportunities, then it shouldn't pay a dividend. If the stock is very cheap, and management wants to return capital, buybacks are a better option.

With (B), as long-term individual investors we will be better off with capital appreciation over dividends given the tax deferral. From the perspective of the company, however, their investor base is not homogenous. While individual investors are much better off w/ appreciation because of tax deferral, tax-exempt entities like pension funds, or hedge funds investing on behalf of tax-exempt entities, don't have to worry about the tax effects of their actions. Thus a large % of the shareholder base may not care about taxes in the way individual investors in a taxable account do.

You've got the right idea.  In regards to point A, most companies do not buy back stock when it is cheap -- they back it back preferentially when it is more expensive, destroying shareholder value.  This also affects your point B, but the notion of the inhomogeneity of the investors base – most of which don't have to worry about the tax effects of their actions – is hugely important.

phillyvalue

  • 5 O'Clock Shadow
  • *
  • Posts: 88
  • Age: 28
  • Location: New York, NY
Dividends are a complicated subject. There are two categories of considerations: (a) how do dividends affect the value of the company, and (b) how do dividends compare in terms of tax efficiency for investors.

With (A), whether a dividend is "good" or not can only be evaluated on a business by business basis. If a company has strong investment opportunities, then it shouldn't pay a dividend. If the stock is very cheap, and management wants to return capital, buybacks are a better option.

With (B), as long-term individual investors we will be better off with capital appreciation over dividends given the tax deferral. From the perspective of the company, however, their investor base is not homogenous. While individual investors are much better off w/ appreciation because of tax deferral, tax-exempt entities like pension funds, or hedge funds investing on behalf of tax-exempt entities, don't have to worry about the tax effects of their actions. Thus a large % of the shareholder base may not care about taxes in the way individual investors in a taxable account do.

You've got the right idea.  In regards to point A, most companies do not buy back stock when it is cheap -- they back it back preferentially when it is more expensive, destroying shareholder value.  This also affects your point B, but the notion of the inhomogeneity of the investors base – most of which don't have to worry about the tax effects of their actions – is hugely important.

Yeah, buybacks are one of those things that were a great idea when certain innovative managers first did them, but now that everyone's doing them, are mostly meaningless. Henry Singleton, the CEO famous for his capital allocation - both buying back stock when cheap and using the stock as currency for M&A when it was expensive - had a quote near the end of his life [by then buybacks were common as they are now], ""If everyone is doing (buybacks), there must be something wrong with them."

With the right management, they have potential, however. For example, Buffett a few years back when he said "We will buy back shares if the stock trades below 1.2X Price to Book." Now that the stock is valued more appropriately, the buybacks have stopped.
« Last Edit: February 25, 2015, 02:30:52 PM by phillyvalue »

brooklynguy

  • Handlebar Stache
  • *****
  • Posts: 2204
  • Age: 39
No one is arguing for a strategy that focuses on dividends.  The OP wrote that share buybacks are more efficient than dividends, and I responded with proof that because of behavioral reasons, the real world doesn't work the same way it should on paper.

Just to be clear, there are parallel debates going on concurrently in this thread, and some people are arguing for a strategy that focuses on dividends.  The "dividend-focused investment strategy" vs. "non-dividend-focused investment strategy" debate is distinct from the "return of capital to investors via dividends" vs. "return of capital to investors via share buybacks" debate (I believe you recognize this, but I'm pointing it out because others following along may not).  I believe both debates are on topic and fair game for discussion in this thread, given that the "dividend apologists" who advocate for dividend-focused strategies were the target of the OP's criticism in the original post.

skyrefuge

  • Handlebar Stache
  • *****
  • Posts: 1007
  • Location: Suburban Chicago, IL
I agree with this point.  The key difference, however, is different company policies regarding dividends and stock buybacks.  As the data I provided show, companies buy back more stock when stock prices are higher, and buy back less when stock prices lower.  Dividends, however, are much more predictable than stock buybacks, and so in practice, stock buybacks have provided less value to investors than dividends.

I think it's worth noting that companies also distribute more dividends when stock prices are higher, and distribute fewer dividends when stock prices are lower. Just trying to order the causality here a bit: it's big earnings that can contribute to both the high stock price and increased return of capital to shareholders (whether via buybacks or dividends), rather than "woo, look at that stock price, let's party and buy back some shares and do some acquisitions and snort some coke off a stripper's ass!"

So sure, if the stock is overvalued, a dividend is probably preferred to a buyback for the non-reinvesting ongoing shareholder, but that depends on him finding a less-overvalued company to invest that dividend in, in what may be an broadly-overvalued market.

I suppose this point is also true but it seems like it misses the overall point.  I personally wouldn't want management of companies I invested to preferentially reward investors who sold their stock instead of rewarding current investors.  And the data show that because of the timing of buybacks management generally rewards former investors instead of current investors.

Yep, I guess that's why that one report stresses "If the company of a stock that you own is buying back shares, you must recognize that doing nothing is doing something." Which is the same as dividends. Reinvesting the dividend, which can seem like a passive "do nothing" strategy, is in fact "doing something". Same with taking the dividend in cash and letting it sit in your bank account. But it's good to point that out for buybacks, since those are less-obviously "do something" moments than dividend payouts.

Ok, and a bunch of more-random thoughts:

In the context of this thread, I think we can say that if a company is simply trying to do a predictable, quarterly return of cash to shareholders, and has narrowed down the choice of what to do with their cash to either buybacks or dividends, buybacks are the better choice. That way investors get better tax treatment, and "dollar-cost averaging" will prevent underperformance. But for that extra "woo, let's party!" cash, I guess a special dividend might be preferred.

Maybe if we can wholly replace the psychological preference for dividends (through threads like this!), then all companies would fully switch over to using buybacks as their cash-return method and thus, buybacks would lose their market-trailing tendencies.

I guess the important thing we don't know is if the magnitude of buyback-underperformance is large enough to outweigh the preferential tax-treatment for a taxable investor. If not, then buybacks are still preferred for that investor, even at their current less-than-awesome success rate.

I've learned that both dividends and buybacks have downsides related to investor freedom, and your preference depends on which downside affects you more. The downside of a dividend is that it removes freedom from the investor regarding when he gets his cash ("here it is, now pay tax on it!"), while the downside of a buyback is that it removes freedom regarding where that cash goes ("I'm gonna reinvest it in this company for you, whether you think that's a good idea or not!")

Again, if an active, direct shareholder thinks it's a bad idea to reinvest in a company, I'm not sure why he's holding that company in the first place, and so he shouldn't have much reason to complain about that forced-reinvestment. And switching to the context of passive investing, the idea that stock can be "overvalued" or "undervalued" doesn't even make sense, so this underperformance of buybacks might not even be a real thing for a passive investor. At the least, the buyback performance would have to be compared against the performance of passively-reinvested dividends to make a valid comparison.

skyrefuge

  • Handlebar Stache
  • *****
  • Posts: 1007
  • Location: Suburban Chicago, IL
Yeah, buybacks are one of those things that were a great idea when certain innovative managers first did them, but now that everyone's doing them, are mostly meaningless. Henry Singleton, the CEO famous for his capital allocation - both buying back stock when cheap and using the stock as currency for M&A when it was expensive - had a quote near the end of his life [by then buybacks were common as they are now], ""If everyone is doing (buybacks), there must be something wrong with them."

"Mostly meaningless"? Just because there are investors and companies for whom a buyback may be less-optimal than a dividend, that hardly makes buybacks meaningless. They're still returns of capital to the investor pool, in exactly the same magnitude as a dividend would be.

Also, if Mr. Singleton thought there was something wrong with buybacks then, he would surely be rolling over in his grave now. In reality, buybacks are far more common than they are when he died.  In 1999, dividends returned 2.2x more cash to shareholders than buybacks. By 2011, it had flipped, with buybacks returning 1.9x more cash to shareholders than dividends.

danclarkie

  • 5 O'Clock Shadow
  • *
  • Posts: 85
  • Age: 32
  • Location: Dubai & Singapore
  • Measure Twice, Cut Once.
    • Dan Clarke
DanClarkie,

You assume dividends get reinvested AND that a fee is charged for such reinvestment.  In my case (FIRE), I spend my dividends

To be fair, the thread title is "Unless you are retired..."

You are retired, and you use the cash flow from your investment dividends to fund your cost of living.
Nobody is arguing against that being a good course of action.

danclarkie

  • 5 O'Clock Shadow
  • *
  • Posts: 85
  • Age: 32
  • Location: Dubai & Singapore
  • Measure Twice, Cut Once.
    • Dan Clarke
But I read so many "dividend stock only" investment plans, all from investors in the growth/accumulation phase of their careers.
If it is empirically proven that the dividend growth strategy is inefficient, why is it so popular?

Because there are a lot of investors out there who don't think as critically about these things as you do. I assume the bizarrely-confrontational and confused comments on your blog post from Dividend Mantra told you something about his intellectual prowess.

Ugh.  It hasn't been empirically proven that a dividend strategy is inferior to other uses of capital.  You have nice mathematical proofs that show that taxes on dividends reduce returns (not very much, because they're so overwhelmingly held in tax-advantaged accounts or are taxed at 0%, but yes! some).

Perhaps "empirical" was the wrong word.
But what about the transaction costs (commissions and fees).
Even in the world of 0% tax that you suggest, these fees would cause the dividend distribution and reinvestment to be less efficient.
If we take out the variable of individual company performance, and their efficiency in distributing capital, does the issue of tax and transaction fees not make dividends inefficient?
Assuming that any dividends paid out from a stock would be reinvested in that same stock, and so the company use of capital to invest in growth would equally affect the shareholder.

Essentially:
If you are going to reinvest dividends into the same company/fund, then the rigmarole of receiving a dividend and then reinvesting it has to be an inefficient way to achieve the same goal of holding more shares in that fund/stock.

I feel now more strongly than ever that dividends for growth investors are an emotional bias, and the cost of such is the reduced efficiency.

vehementi

  • 5 O'Clock Shadow
  • *
  • Posts: 6
Holy crap, it took me over 20 tries to defeat the captcha to register here.

Anyway, I came to this same conclusion as you.  As a Canadian investor I need to choose what to do for my US equity.  If I put it in my RRSP (like your 401k or something) then the dividend withholding tax doesn't actually apply, so that's cool.

But I have a similar situation with my taxable account - dividends getting taxed nonstop will lower my growth RATE, which is the cardinal sin.  And until I retire, all I care about is getting the largest number of dollars worth of equity, which I can later trade into dividend-paying devices if that's what I want.

It turns out the answer right now for taxable accounts is swap-based ETFs - no dividends ever happen so I don't get taxed on them, and it's just like making everything pay no dividends and grow accordingly.  See http://canadiancouchpotato.com/2013/10/15/more-swap-based-etfs-on-the-horizon/

vehementi

  • 5 O'Clock Shadow
  • *
  • Posts: 6
True for taxable accounts (manually recover through tax credits) - in RRSP the 15% (or 30% if you didn't provide a W-8BEN to brokerage or they're doing it wrong) doesn't apply.

danclarkie

  • 5 O'Clock Shadow
  • *
  • Posts: 85
  • Age: 32
  • Location: Dubai & Singapore
  • Measure Twice, Cut Once.
    • Dan Clarke
Holy crap, it took me over 20 tries to defeat the captcha to register here.

Anyway, I came to this same conclusion as you.  As a Canadian investor I need to choose what to do for my US equity.  If I put it in my RRSP (like your 401k or something) then the dividend withholding tax doesn't actually apply, so that's cool.

But I have a similar situation with my taxable account - dividends getting taxed nonstop will lower my growth RATE, which is the cardinal sin.  And until I retire, all I care about is getting the largest number of dollars worth of equity, which I can later trade into dividend-paying devices if that's what I want.

It turns out the answer right now for taxable accounts is swap-based ETFs - no dividends ever happen so I don't get taxed on them, and it's just like making everything pay no dividends and grow accordingly.  See http://canadiancouchpotato.com/2013/10/15/more-swap-based-etfs-on-the-horizon/


But, again, regardless of tax offsets you are able to find.
The commissions and brokerage fees would also make this sub-optimal even if you could offset 100% of the tax hit, right?

Unless you can claim brokerage fees/commissions as some tax deducatable?!

Sorry I live in Dubai, everything is entirely tax free.

vehementi

  • 5 O'Clock Shadow
  • *
  • Posts: 6
Not sure what you mean - well, there will always be fees so I'm not sure what about my case you are asserting is different.  In any event, my brokerage has free ETF buys so unless I do dumb things, the fees are negligible.

vehementi

  • 5 O'Clock Shadow
  • *
  • Posts: 6
Yeah so the whole picture for a Canadian owning US equity in a taxable account, to my knowledge, is:

1) -15% of dividends lost to withholding tax, but is probably recoverable through foreign tax credit
2) all dividends are anyway taxable at my full marginal rate
3) MER of fund

VUN (the typical ETF I'd use for US equity in a taxable account) has a MER of 0.17%.  If we assume the withholding tax vanishes, then the only other tracking error under my control is my marginal rate on dividends.  So dividends pay out at like 2%, and if my marginal rate is lke 40%, then that's another 0.80% of tracking error (lost growth).  Super brutal.

If on the other hand I use HXS, a swap-based ETF, which has a MER of 0.15% and a swap fee of up to 0.30%, my total tracking error is like 0.45%.  Less horrible.

Both cases would have the same taxable gains situation in the end, unless there's some cancelling going on.

beltim

  • Magnum Stache
  • ******
  • Posts: 2884
In the context of this thread, I think we can say that if a company is simply trying to do a predictable, quarterly return of cash to shareholders, and has narrowed down the choice of what to do with their cash to either buybacks or dividends, buybacks are the better choice. That way investors get better tax treatment, and "dollar-cost averaging" will prevent underperformance. But for that extra "woo, let's party!" cash, I guess a special dividend might be preferred.

Maybe if we can wholly replace the psychological preference for dividends (through threads like this!), then all companies would fully switch over to using buybacks as their cash-return method and thus, buybacks would lose their market-trailing tendencies.

I really thought you got my point when you said this (although you keep bringing up active investing even though stock buybacks destroy shareholder value for index investors too).  But then you said this:

"Mostly meaningless"? Just because there are investors and companies for whom a buyback may be less-optimal than a dividend, that hardly makes buybacks meaningless. They're still returns of capital to the investor pool, in exactly the same magnitude as a dividend would be.

Also, if Mr. Singleton thought there was something wrong with buybacks then, he would surely be rolling over in his grave now. In reality, buybacks are far more common than they are when he died.  In 1999, dividends returned 2.2x more cash to shareholders than buybacks. By 2011, it had flipped, with buybacks returning 1.9x more cash to shareholders than dividends.

My entire point is that stock buybacks can actually destroy shareholder value.  Most often they destroy shareholder value relative to paying a dividend, but the frequently result in not just relative but absolute losses to investors.  In this case, stock buybacks are worse than doing nothing – they are management actively losing money for investors.

beltim

  • Magnum Stache
  • ******
  • Posts: 2884
But I read so many "dividend stock only" investment plans, all from investors in the growth/accumulation phase of their careers.
If it is empirically proven that the dividend growth strategy is inefficient, why is it so popular?

Because there are a lot of investors out there who don't think as critically about these things as you do. I assume the bizarrely-confrontational and confused comments on your blog post from Dividend Mantra told you something about his intellectual prowess.

Ugh.  It hasn't been empirically proven that a dividend strategy is inferior to other uses of capital.  You have nice mathematical proofs that show that taxes on dividends reduce returns (not very much, because they're so overwhelmingly held in tax-advantaged accounts or are taxed at 0%, but yes! some).

Perhaps "empirical" was the wrong word.
But what about the transaction costs (commissions and fees).
Even in the world of 0% tax that you suggest, these fees would cause the dividend distribution and reinvestment to be less efficient.
If we take out the variable of individual company performance, and their efficiency in distributing capital, does the issue of tax and transaction fees not make dividends inefficient?
Assuming that any dividends paid out from a stock would be reinvested in that same stock, and so the company use of capital to invest in growth would equally affect the shareholder.

Essentially:
If you are going to reinvest dividends into the same company/fund, then the rigmarole of receiving a dividend and then reinvesting it has to be an inefficient way to achieve the same goal of holding more shares in that fund/stock.

I feel now more strongly than ever that dividends for growth investors are an emotional bias, and the cost of such is the reduced efficiency.

Why do you think the company would have no fees buying back stock?  I would argue that they incur more fees buying back stock than the sum of costs they incur paying a dividend plus whatever miniscule transaction costs you incur (for example, dividend reinvetment has been free at major brokerages for about the last 20 years, so the most you're paying is a few cents per share in bid/ask spread).

YoungInvestor

  • Bristles
  • ***
  • Posts: 408
Most big companies pay dividends, so if I was restricting myself from investing (through any instrument) in them, I wouldn't be doing much investing at all.

I much prefer share buybacks. Pretty clean way to get the money back to shareholders.

danclarkie

  • 5 O'Clock Shadow
  • *
  • Posts: 85
  • Age: 32
  • Location: Dubai & Singapore
  • Measure Twice, Cut Once.
    • Dan Clarke
My entire point is that stock buybacks can actually destroy shareholder value.  Most often they destroy shareholder value relative to paying a dividend, but the frequently result in not just relative but absolute losses to investors.  In this case, stock buybacks are worse than doing nothing – they are management actively losing money for investors.

I'm not following this train of thought.
How do stock buybacks destroy shareholder value?

Why do you think the company would have no fees buying back stock?  I would argue that they incur more fees buying back stock than the sum of costs they incur paying a dividend plus whatever miniscule transaction costs you incur (for example, dividend reinvetment has been free at major brokerages for about the last 20 years, so the most you're paying is a few cents per share in bid/ask spread).

From personal experience, the piss-poor selection of brokerages for non-resident aliens mean there is no real competition and the idea of fee free dividend reinvestments, is something I fear will be out of reach for perhaps another 20 years.

I'm not sure that I said the company would have no fees in making a buyback, but that the process of an internal buyback would be more efficient that processing a dividend payment to shareholders, for the shareholder to then reinvest that dividend in buying more shares of that company.

Not least because, a share buyback can achieve this without the need for a shreholder to buy fractional shares. Something also not offered by my non-resident alien brokerage.

The issues with DRIP then are:
  • Tax and or tax withholding on dividend payments
  • Requirement to purchase fractional shares
  • Transaction costs (Commissions/fees)
  • Bid Ask spread

Unless your account is in a tax sheltered environment, your brokerage offers commission-free dividend reinvestments, the ability to purchase fractional shares, and a negligible bid/ask spread...
Then a dividend payment is going to be, at best, annoying.

Even if we take out the idea of share buybacks.
If the company left the money in their account and used it to fund ventures or M&A's, that would be more efficient than a DRIP.

No?

beltim

  • Magnum Stache
  • ******
  • Posts: 2884
My entire point is that stock buybacks can actually destroy shareholder value.  Most often they destroy shareholder value relative to paying a dividend, but the frequently result in not just relative but absolute losses to investors.  In this case, stock buybacks are worse than doing nothing – they are management actively losing money for investors.

I'm not following this train of thought.
How do stock buybacks destroy shareholder value?


See the link I posted, as well as at least the first link that skyrefuge posted.  Basically, when directly compared to a dividend, there's no difference at any particular point in time.  But because dividend policies in the US are relatively consistent (management is loathe to reduce dividends unless it's their last option), while stock buybacks are highly cyclical (companies buy back far more stock when the market is high, and a lot less when the market is low), the net effect to investors is that dividends are a far superior return of capital than stock buybacks.

If stock buybacks were as consistent or more consistent than dividends, this wouldn't be the case.  But I don't know of any companies that buy back stock more consistently than pay dividends.

danclarkie

  • 5 O'Clock Shadow
  • *
  • Posts: 85
  • Age: 32
  • Location: Dubai & Singapore
  • Measure Twice, Cut Once.
    • Dan Clarke
My entire point is that stock buybacks can actually destroy shareholder value.  Most often they destroy shareholder value relative to paying a dividend, but the frequently result in not just relative but absolute losses to investors.  In this case, stock buybacks are worse than doing nothing – they are management actively losing money for investors.

I'm not following this train of thought.
How do stock buybacks destroy shareholder value?


See the link I posted, as well as at least the first link that skyrefuge posted.  Basically, when directly compared to a dividend, there's no difference at any particular point in time.  But because dividend policies in the US are relatively consistent (management is loathe to reduce dividends unless it's their last option), while stock buybacks are highly cyclical (companies buy back far more stock when the market is high, and a lot less when the market is low), the net effect to investors is that dividends are a far superior return of capital than stock buybacks.

If stock buybacks were as consistent or more consistent than dividends, this wouldn't be the case.  But I don't know of any companies that buy back stock more consistently than pay dividends.

Ah, right, I see.
So this relates to the practical implementation of share buybacks (and their infrequency/lack of expectation) versus dividend distributions, rather than the theoretical basis behind the method of distribution of wealth to shareholders.
Makes sense now, thanks :)

beltim

  • Magnum Stache
  • ******
  • Posts: 2884
Why do you think the company would have no fees buying back stock?  I would argue that they incur more fees buying back stock than the sum of costs they incur paying a dividend plus whatever miniscule transaction costs you incur (for example, dividend reinvetment has been free at major brokerages for about the last 20 years, so the most you're paying is a few cents per share in bid/ask spread).

From personal experience, the piss-poor selection of brokerages for non-resident aliens mean there is no real competition and the idea of fee free dividend reinvestments, is something I fear will be out of reach for perhaps another 20 years.

I'm not sure that I said the company would have no fees in making a buyback, but that the process of an internal buyback would be more efficient that processing a dividend payment to shareholders, for the shareholder to then reinvest that dividend in buying more shares of that company.

Not least because, a share buyback can achieve this without the need for a shreholder to buy fractional shares. Something also not offered by my non-resident alien brokerage.

The issues with DRIP then are:
  • Tax and or tax withholding on dividend payments
  • Requirement to purchase fractional shares
  • Transaction costs (Commissions/fees)
  • Bid Ask spread

Unless your account is in a tax sheltered environment, your brokerage offers commission-free dividend reinvestments, the ability to purchase fractional shares, and a negligible bid/ask spread...
Then a dividend payment is going to be, at best, annoying.

I'm sorry brokerages in your country appear to suck.  I can see why you personally don't like dividends -- but you have to realize you're in a small minority of investors in US stocks.

Quote
Even if we take out the idea of share buybacks.
If the company left the money in their account and used it to fund ventures or M&A's, that would be more efficient than a DRIP.

No?
It could be, it depends on the company and the venture.  One of the links skyrefuge posted indicated that companies had the highest return on investment for capital projects within their own company.  M&A activity usually benefited the selling company, but was pretty neutral for the acquiring company.

beltim

  • Magnum Stache
  • ******
  • Posts: 2884
My entire point is that stock buybacks can actually destroy shareholder value.  Most often they destroy shareholder value relative to paying a dividend, but the frequently result in not just relative but absolute losses to investors.  In this case, stock buybacks are worse than doing nothing – they are management actively losing money for investors.

I'm not following this train of thought.
How do stock buybacks destroy shareholder value?


See the link I posted, as well as at least the first link that skyrefuge posted.  Basically, when directly compared to a dividend, there's no difference at any particular point in time.  But because dividend policies in the US are relatively consistent (management is loathe to reduce dividends unless it's their last option), while stock buybacks are highly cyclical (companies buy back far more stock when the market is high, and a lot less when the market is low), the net effect to investors is that dividends are a far superior return of capital than stock buybacks.

If stock buybacks were as consistent or more consistent than dividends, this wouldn't be the case.  But I don't know of any companies that buy back stock more consistently than pay dividends.

Ah, right, I see.
So this relates to the practical implementation of share buybacks (and their infrequency/lack of expectation) versus dividend distributions, rather than the theoretical basis behind the method of distribution of wealth to shareholders.
Makes sense now, thanks :)

Exactly.

YoungInvestor

  • Bristles
  • ***
  • Posts: 408
My entire point is that stock buybacks can actually destroy shareholder value.  Most often they destroy shareholder value relative to paying a dividend, but the frequently result in not just relative but absolute losses to investors.  In this case, stock buybacks are worse than doing nothing – they are management actively losing money for investors.

I'm not following this train of thought.
How do stock buybacks destroy shareholder value?


See the link I posted, as well as at least the first link that skyrefuge posted.  Basically, when directly compared to a dividend, there's no difference at any particular point in time.  But because dividend policies in the US are relatively consistent (management is loathe to reduce dividends unless it's their last option), while stock buybacks are highly cyclical (companies buy back far more stock when the market is high, and a lot less when the market is low), the net effect to investors is that dividends are a far superior return of capital than stock buybacks.

If stock buybacks were as consistent or more consistent than dividends, this wouldn't be the case.  But I don't know of any companies that buy back stock more consistently than pay dividends.

Wouldn't it be a positive aspect that management does not have to stick to a dividend policy?

Some companies may feel the need to keep paying a dividend even if they would be better off keeping some money or be reluctant to increase their dividends for fear that they will need to keep the same level over time.

With buybacks, companies can better time their cash flows to make sure that they are in accordance with the company's long-term strategic vision.

I do agree that it makes things less predictable for investors.